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Commodity Derivatives Market in India Research Team | Posted On Saturday, April 18,2009, 10:19 AM

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Commodity Derivatives Market in India



Commodity Derivatives Market in India:

The Indian economy is observing a mini revolution in commodity derivatives and as well as risk management. Commodity options trading and cash settlement of commodity futures had been forbidden since 1952 and until 2002 commodity derivatives market was practically non-existent, except some negligible activity on an OTC basis. In September 2005, the country had 3 national level electronic exchanges and for about 21 regional exchanges for trading commodity derivatives. For about eighty (80) commodities had been allowed for derivatives trading.

Commodity market trading:


The history of organized commodity derivatives in India started in the nineteenth century when the Cotton Trade Association established futures trading in 1875; it is just about a decade after the commodity derivatives started in Chicago. Over time the derivatives market developed in a number of other commodities in India. Following cotton, derivatives trading established in oilseeds in Bombay (1900), raw jute and jute goods in Calcutta (1912), wheat in Hapur (1913) and also in Bullion in Bombay (1920).

Still, many feared that derivatives fuelled unnecessary speculation in vital commodities, and were unfavorable to the healthy functioning of the markets for the underlying commodities, and thus to the farmers. In order to restrict speculative activity in cotton market, the Government of Bombay forbidden options business in cotton in 1939. Afterwards in 1943, forward trading was banned in oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar and cloth.

After August 1947, i.e. after independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which synchronized forward contracts in commodities all over India. The Act applies to goods, which may be defined as any movable property other than security, currency and actionable claims. The Act banned options trading in goods along with cash settlements of forward trades, rendering a crushing blow to the commodity derivatives market. Under this Act, only those associations/exchanges, which are of approved recognition by the Government, are allowed to organize forward trading in regulated commodities. The Act foreseen three-tier regulation :

  • The Exchange which organizes forward trading in commodities can regulate trading on a day-to-day basis
  • The Forward Markets Commission affords regulatory oversight under the powers delegated to it by the central Government, and
  • The Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution - is the final regulatory authority.

    The previously shaken commodity derivatives market got a crushing blow when in 1960s, following several years of brutal draughts that forced many farmers to default on forward contracts (and even caused some suicides); forward trading was forbidden in many commodities considered primary or essential. Accordingly, commodities derivative markets dismantled and went underground where to some degree they continued as OTC contracts at negligible volumes. ? In a while, in 1970s and 1980s the Government relaxed forward trading rules for some of the commodities, but the market could never recover the lost volumes.

Change in Government Policy

After, the Indian economy set out on the process of liberalization and globalization, in 1990, the Government set up a Committee in 1993 to study the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended permitting futures trading in 17 commodity groups. It also recommended strengthening of the Forward Markets Commission, and definite amendments to Forward Contracts (Regulation) Act 1952, mainly allowing options trading in goods and registration of brokers with Forward Markets Commission.

The Government accepted the majority of these recommendations and futures trading were permitted in all recommended commodities. Commodity futures trading in India remained in a state of inactivate for almost four decades. This was chiefly due to doubts about the benefits of derivatives. Lastly a realization that derivatives do perform a role in risk management led the government to change its attitude or position. The policy changes favoring commodity derivatives were also facilitated by the improved role assigned to free market forces under the new liberalization policy of the Government. Certainly, it was a timely decision too, because internationally the commodity cycle is on the upswing and the next decade is being touted as the decade of commodities.

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